Annex 1. Country Case Studies
Denmark
Background
In July 2012, the Danish central bank was the first country to cut its main official policy interest rate—the interest rate on bank certificates of deposit— into negative territory.1,2 This was done as a means of defending the Danish krone’s peg with the euro. The Danmarks Nationalbank (DN) has been successful in keeping the krone closely aligned with euro. However, as with other central banks that were focused on preventing an excessive appreciation of their currencies, at least initially, there were serious doubts about the transmission of negative rates to other interest rates, output, and prices (IMF 2017).
Effects
Since 2017, there is mounting evidence that negative rates are increasingly being transmitted to both deposit and lending rates. For example, several commercial banks are now charging the central bank’s benchmark rate (–0.75 percent) on corporate and moderate-size retail deposits,3 and 10-year mortgages are being issued at rates as low as –0.5 percent.4 In addition, interest rates on short-term bank loans to nonfinancial corporations have been close to zero since at least mid-2018. However, the successful transmission of negative rates to lending rates is, to some extent, the result of Denmark’s unique mortgage market where mortgage originators (banks and mortgage companies) collect fees from financing and refinancing but then securitize the loans.5
Despite having to live with negative interest rates for most of the last eight years, bank profits in Denmark have not suffered. The resilience of bank profits stems partly from their ability to adapt business models and to rely more on fee income. There is also little evidence that negative rates have encouraged zombie lending. Lending to mature firms with negative interest coverage ratios (ICR)6 as a share of total lending has declined since 2011 (Danmarks Nationalbank 2019).
Euro Area
Background
The European Central Bank (ECB) introduced NIRP in June 2014, when it lowered the interest rate on its deposit facility to –0.10 percent. Since then, the ECB has cut the deposit facility rate four more times, always in steps of 10 basis points. As a result, the rate on the deposit facility has been stand-ing at –0.50 percent since September 2019. Crucially, the deposit rate has been the relevant ECB policy rate since the onset of the sovereign debt crisis. Owing to the adoption of other unconventional measures, such as targeted and non-targeted longer-term refinancing operations and assets purchase programs, banks in the euro area hold a large amount of excess liquidity. There-fore, even before the adoption of NIRP, the cost of depositing reserves at the central bank rather than the rate on refinancing operations was determining the overnight unsecured rate, which is the ECB’s (implicit) operational target and the effective marginal policy rate.
The main reason to adopt NIRP was to provide additional monetary stim-ulus in a context characterized by strong disinflationary pressures. Given the lack of consensus on launching a large-scale asset purchase program, the Governing Council of ECB opted for lowering the deposit rate below zero to maintain price stability. However, other reasons may have played an important role. For instance, a reduction in the deposit rate allows for the interest rate corridor to widen, providing incentives to participate in the interbank market. A wider corridor incentivizes banks that need liquidity to tap money markets instead of borrowing from the central bank. Symmetrically, the increased cost of holding reserves creates a “hot potato” effect. By providing incentives to borrow and lend out reserves in the interbank market, the ECB aimed at reducing segmentation, as the distribution of excess liquidity was highly uneven across countries and financial institution.
Effects
Data on macro-financial variables suggest that the transmission of negative rates has been fast and effective. The exchange rate has depreciated significantly after the introduction of NIRP, contributing to boosting exports and economic activity.7 Bank lending rates have declined for both households and firms, with their dispersion across countries falling as well. This reduction in the cost of credit has supported credit growth and investment. The transmission to deposit rates has also been quick, even if it seems to have slowed down as they approach the ZLB. Despite the widespread decline in deposit rates, the use of cash does not seem to have grown. Boucinha and Burlon (2020) corroborate these findings by providing evidence that negative interest rates have supported economic activity and ultimately contributed to price stability.
While recognizing NIRP’s contribution in delivering the needed monetary accommodation, the ECB has become increasingly concerned about the potential negative impact of negative policy rates on bank profitability. To partially offset the fall in banks’ net interest margin, in September 2019 the ECB introduced a multi-tier regime, similar to those already adopted by other central banks. In particular, the ECB has chosen a two-tier system for reserve remuneration, in which liquidity up to six times the reserve requirement is remunerated at zero percent rather than at the deposit facility rate. Both the multiplier on reserve requirement and the interest rate can be changed over time. This system reflects the necessity to weaken the side effects of NIRP on bank profitability in a context where the distribution of excess liquidity is highly heterogeneous. The adoption of a two-tier system also aims to increase the average return on reserves, disincentivizing their substitution with cash.
In March 2020, the ECB decided to lower the interest rate on the funds borrowed through TLTROs to negative territory. Specifically, banks that met determined thresholds in terms of lending to the nonfinancial private sector were charged an interest rate 0.5 percent below the average rate on the deposit facility prevailing between June 2020 and June 2021, and in any case not higher than –1 percent. Although this decision may appear as a further step toward reaching the ELB, the effects are very different from those of a cut in official rates. As explained earlier, NIRP is typically considered a nonstandard measure mainly because it potentially involves an asymmetric impact on banks’ assets and liabilities, possibly harming their probability. In the case of TLTROs, the ECB reduces the rate on funds borrowed from the central bank, thus lowering the cost of funding of financial intermediaries. By reducing the spread between the average return on bank assets and liabilities, this monetary policy decision softens, rather than exacerbates, the potential side effects associated with NIRP.
Japan
Background
The Bank of Japan (BOJ) announced on January 29, 2016, that a negative interest rate on excess reserves would be implemented on February 16, 2016. This was nearly three years after the introduction of quantitative and qualitative easing (QQE). After its deployment, the QQE framework helped boost economic activity, inflation, and inflation expectations (BOJ 2016, Hattori and Yetman 2017). Nonetheless, inflation persistently stayed below the 2 percent target of BOJ, and by the summer of 2015 both the domestic and global outlooks started to weaken. Amid intensifying financial turbulence in emerging markets, an appreciating yen, and falling oil prices during late 2015, economic activity in Japan softened, equity markets contracted sharply, and inflation started to decline.
The BOJ complemented QQE with negative interest rates to further lower the short end of the yield curve and reinforce its commitment to an inflation target of 2 percent. Since the price stability target had not been achieved for a long period in Japan, the backward component of inflation expectations in Japan was high, and stronger than in other large economies. Moreover, BOJ’s own analysis suggested that the improvement in the output gap brought about by a unit decline in the real interest rate at each maturity tranche was largest at maturities of 1–2 years, but gradually became smaller the longer the maturity (BOJ 2016).
Effects
Following the introduction of NIRP, interest rates across the entire yield curve fell to such a degree that the yield curve flattened. The large drop in longer maturities was in part due to NIRP being accompanied by continuing Japanese government bond (JGB) purchases by the BOJ, compressing risk premiums. In addition, intensified search for positive yield by financial institutions drove up the demand for assets with a positive interest rate, driving down super-long-term JGB yields (BOJ 2016).
Lending and deposit rates also fell, compressing lending margins, but without evidence that financial institutions’ functioning as intermediaries has been impaired. This may have been in part due to the three-tier reserve deposit system that the BOJ introduced to mitigate the direct impact on financial institutions’ profits (IMF 2017). In addition, NIRP has translated into a fall on corporate yields as well, triggering a pickup, in particular, in the issuance of very long-term corporate bonds.
Overall, NIRP in Japan has stimulated activity and inflation, but has been insufficient considering the Bank of Japan’s price stability objectives. Survey and market-based inflation expectations continued to slide down and economic activity remained tepid. In response, the BOJ introduced a new policy framework (Quantitative and Qualitative Monetary Easing with Yield Curve Control) on September 2016, which aimed to control both short-term and long-term interest rates to directly target the slope of the yield curve to better calibrate the monetary policy stimulus and alleviate the burden of low interest rates on financial intermediaries. Within the new framework, BOJ has also committed to overshoot its inflation target until the year-over-year rate of increase in the observed consumer price index exceeds the price stability target of 2 percent and stays above the target in a stable manner (BOJ 2016). Since then, macroeconomic outcomes have somewhat improved, though actual and expected inflation remain below the inflation target (Westelius 2020).
Sweden
Background
In July 2009, Sweden was in the midst of the downturn that had spread across its trading partners following the global financial shocks of the fall of 2008. The Riksbank—Sweden’s central bank—lowered its main policy rate, the repo rate, to 25 basis points and its deposit rate to –25 basis points. With this action, the Riksbank became the first central bank to cut one of its policy rates (albeit not the main one, which in Sweden is the repo rate) below zero.8 The period of negative rates did not last long. By the middle of the following year, rates started to move upward as the central bank became increasingly concerned with building financial imbalances.9
At the time of its 2009 decision, the Riksbank Executive Board judged that 25 basis points was the lower limit of its repo rate “in practice.”10 But as other central banks have found, what is taken to be a lower limit can change over time. Declining inflation expectations and weak demand conditions through 2012–14 led the Riksbank to ease policy once again, and in February 2015 it set its main repo rate below zero for the first time, at –10 basis points. A further sequence of cuts followed, bringing the repo rate to –50 basis points between February 2016 and January 2019.
As in other countries, NIRP was enacted alongside an asset purchase pro-gram and forward guidance. These three elements of unconventional policy combined produced substantial policy easing (see IMF 2015, paragraphs 14–19). Further discussion of how NIRP can reinforce other measures appears in Chapter 2.
In December 2018, the Riksbank announced that it would start to raise its repo rate, while maintaining the size of its asset purchase program. The fol-lowing December, it became the first central bank to announce its exit from NIRP, when it increased the repo rate back to zero, while citing an inflation rate close to the 2 percent target and an expansion in economic activity. As of January 2021, the deposit rate remains negative at –10 basis points.
Effects
There is evidence that the Riksbank’s negative rate policy resulted in Swedish banks cutting both deposit and lending rates (see Erikson and Vestin 2019). But as Chapter 3 discusses, the pass-through to deposit rates looks to have weakened with successive cuts. Some research has pointed toward small negative effects, or even slightly positive effects, on lending rates from NIRP (Eggertsson and others 2019).11 However, more than three years after NIRP was introduced, Swedish banks continued to report strong profitability (IMF 2019). More context on the pass-through of negative rates, and their potential effects on bank profitability, is given in Chapter 3.
Switzerland
Background
The Swiss National Bank (SNB) adopted negative rates on commercial bank deposits to keep Swiss interest rates below those of the euro (Danthine 2018). This, in turn, was enacted to stem a capital inflow surge (exacerbated by its safe-haven status) and thus prevent an excessive appreciation of the Swiss franc and associated defationary pressure (Jordan 2020).12
Following QE by ECB in August 2011, the three-month interest rate dif-ferential between the Swiss franc and the euro basically vanished. Ruling out the possibility of implementing QE because of a small domestic capital market (Jordan 2020), the SNB responded by imposing a floor on the franc/ euro exchange rate. The floor lasted until January 2015, after which the SNB cut the deposit rate to –0.75 and a negative interest rate differential returned. The SNB complemented the negative interest rate policy with the announcement that it would remain active in the FX market if necessary. The FX interventions ultimately led to a large expansion of its balance sheet (Danthine 2018).
Effects
Pass-through to bank lending rates was initially low, suggesting the relevant transmission channel was the exchange rate. Although the rate cuts into negative territory produced a level shift in the yield curve and have not weakened the transmission of short rate cuts along the curve (Grisse and Schumacher 2018), Swiss banks did not initially reduce the rates they charge on their lending, including on mortgage lending (Danthine 2018). This could have been because of their inability to reduce funding costs, given the low pass-through to customer deposit rates, because of market power in lending markets, or simply reflect rising credit risk associated with overstretched valuations. More recently, shorter-term lending rates in particular have seen some sizeable declines.
Low pass-through of negative rates to deposit rates at commercial banks has meant that the risk of cash hoarding by depositors is still low. The SNB has gone farther than any other central bank in setting a negative interest rate. However, significant exemptions have meant that the average rate on deposits at the SNB is significantly higher than the marginal rate. Furthermore, since commercial banks have refrained from passing on negative rates to small depositors,13 the ZLB still holds for these deposits. Therefore, the SNB may still have room to cut the marginal deposit rate further (Jordan 2020), at least based on market-implied beliefs (Grisse and Schumacher 2018).
Annex 2. The sts of Structural Breaks after NIRP
As of June 13, 2019, the SNB policy rate replaced the target range for the three-month Swiss franc LIBOR previously used in the SNB’s monetary policy strategy.
| Denmark | |
| Policy rate | Interbank rate “Tomorrow/Next” |
| Bank rate on household deposits | Interest rate on domestic deposits in DKK held by households |
| Bank rate on NFCs deposits | Interest rate on domestic deposits in DKK held by nonfinancial corporations |
| Bank rate on mortgages to households | Interest rates on new loans to households for house purchase |
| Bank rate on loans to NFCs | Interest rates on new loans to nonfinancial corporations (Including repos) |
| Euro area | |
| Policy rate | EONIA |
| Bank rate on household deposits | Interest rates on new overnight deposits held by households |
| Bank rate on NFCs deposits | Interest rates on new overnight deposits held by nonfinancial corporations |
| Bank rate on mortgages to households | Interest rates on new loans to households for house purchase with initial maturity up to one year |
| Bank rate on loans to NFCs | Interest rates on new loans to nonfinancial corporations with initial maturity up to one year (excluding revolving lines) |
| Japan | |
| Policy rate | Uncollateralized overnight interbank rate |
| Bank rate on deposits | Interest rate on ordinary deposits |
| Bank rate on time deposits | Average interest rate on time deposits |
| Bank rate on mortgages to households | Interest rate on housing loans with floating rates by city banks |
| Bank rate on loans to NFCs | Interest rates on new short-term loans |
| Sweden | |
| Policy rate | STIBOR “Tomorrow/Next” |
| Bank rate on household deposits | New bank deposit rates for households |
| Bank rate on NFCs deposits | New bank deposit rates for nonfinancial corporations |
| Bank rate on mortgages to households | New bank loans to households for housing |
| Bank rate on loans to NFCs | New MFI loans to nonfinancial corporations |
| Switzerland | |
| Policy rate | Swiss three-month LIBOR1 |
| Bank rate on deposits | Interest rate on savings deposits for private clients |
| Bank rate on mortgages to households | Interest rate on mortgages with fixed interest rates |
| Bank rate on loans to NFCs | Interest rate on investment loans with fixed interest rates |
As of June 13, 2019, the SNB policy rate replaced the target range for the three-month Swiss franc LIBOR previously used in the SNB’s monetary policy strategy.
| Denmark | |
| Policy rate | Interbank rate “Tomorrow/Next” |
| Bank rate on household deposits | Interest rate on domestic deposits in DKK held by households |
| Bank rate on NFCs deposits | Interest rate on domestic deposits in DKK held by nonfinancial corporations |
| Bank rate on mortgages to households | Interest rates on new loans to households for house purchase |
| Bank rate on loans to NFCs | Interest rates on new loans to nonfinancial corporations (Including repos) |
| Euro area | |
| Policy rate | EONIA |
| Bank rate on household deposits | Interest rates on new overnight deposits held by households |
| Bank rate on NFCs deposits | Interest rates on new overnight deposits held by nonfinancial corporations |
| Bank rate on mortgages to households | Interest rates on new loans to households for house purchase with initial maturity up to one year |
| Bank rate on loans to NFCs | Interest rates on new loans to nonfinancial corporations with initial maturity up to one year (excluding revolving lines) |
| Japan | |
| Policy rate | Uncollateralized overnight interbank rate |
| Bank rate on deposits | Interest rate on ordinary deposits |
| Bank rate on time deposits | Average interest rate on time deposits |
| Bank rate on mortgages to households | Interest rate on housing loans with floating rates by city banks |
| Bank rate on loans to NFCs | Interest rates on new short-term loans |
| Sweden | |
| Policy rate | STIBOR “Tomorrow/Next” |
| Bank rate on household deposits | New bank deposit rates for households |
| Bank rate on NFCs deposits | New bank deposit rates for nonfinancial corporations |
| Bank rate on mortgages to households | New bank loans to households for housing |
| Bank rate on loans to NFCs | New MFI loans to nonfinancial corporations |
| Switzerland | |
| Policy rate | Swiss three-month LIBOR1 |
| Bank rate on deposits | Interest rate on savings deposits for private clients |
| Bank rate on mortgages to households | Interest rate on mortgages with fixed interest rates |
| Bank rate on loans to NFCs | Interest rate on investment loans with fixed interest rates |
As of June 13, 2019, the SNB policy rate replaced the target range for the three-month Swiss franc LIBOR previously used in the SNB’s monetary policy strategy.
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Vault cash has been increasing in the United States as well, despite the fact that policy rates have remained in positive territory.
The average level of the neutral rate over long periods is thought to be influenced principally by real eco¬nomic forces—in particular, the economy’s rate of technological progress, demographic trends, and factors affecting the global balance of saving and investment. Monetary policy itself is not thought to be a principal determinant of the neutral real rate.
In this view, financial markets may in part interpret APPs as a commitment by the central bank to keep policy rates low. The signal is credible, so the argument goes, because raising rates while holding a large port¬folio of long-duration assets would lead the central bank to take losses, which may lead to political or reputational costs.
Various schemes have been suggested to relax the technological constraint on constant face value through varieties of tax or other administrative measures, or by the abolition of physical cash itself, including through the adoption of central bank digital currencies (Rogoff 2017a, 2017b; Assenmacher and Krogstrup 2018; and Agarwal and Kimball 2019). If successful, such schemes would lower the ELB, but this paper does not evaluate them.
In a system with reserve requirements (a minimum ratio of reserves to certain types of commercial bank deposit), those requirements may be met with vault cash rather than deposits in some jurisdictions. This was mostly the case in the United States prior to the global financial crisis, for example. But in other important jurisdictions, such as the euro area, cash is ineligible for meeting reserve requirements. Recent liquidity regulation means that banks must hold “high quality liquid assets: such as reserves and government bills in proportion to certain short-term wholesale liabilities. When policy rates are negative, the rates on government bills are likely to be negative too.
For example, Federal Reserve Board staff estimated that short-term rates could not be driven below –30/–35 basis points without triggering large withdrawals of reserves by banks (Burke and others 2010).
Although this cost has likely remained stable over time, financial innovation may cause to fluctuate. For example, the dissemination of privately sponsored digital currencies as an alternative to cash could raise the ELB.
For example, the Central Bank of Chile recently stated that the “technical minimum for its policy rate was 50 basis points.” See Central Bank of Chile (2020).
Since, as mentioned above, retail deposits may be flightier the lower bound for these deposits may be higher than the lower bound on reserves.
Witmer and Yang (2015) look at data on the costs to store and insure precious metals and find that the cost of holding cash ranges between 25 and 50 basis points. If cash is used to settle payments twice a month, the same authors estimate that transportation costs would amount to 25 basis points.
It is usually accepted that efforts consisting in lowering the usage of cash and promoting access to financial products are important to boost financial inclusion and limit informality. NIRPs could be counterproductive in this context since they may increase the role of cash as a store of value and lower the opportunity cost of tax evasion.
Another reason could be that most EMDEs are running persistent current account deficits and need to attract capital flows to finance these deficits. Notably, so far, countries that have implemented NIRPs have been AEs with current account surpluses.
In principle, the reversal rate could be positive, although this appears to be unlikely in practice for jurisdictions currently implementing NIRP. However, in EMDEs, the reversal rate could be positive (that is, there could be a positive interest rate below which monetary easing can be contractionary) because of the way capital flows and collateral constraints interact (Cavallino and Sandri 2020).
That is, central banks may estimate that they will reach the reversal rate before reaching the “technical” minimum represented by the ELB. Alternatively, the reversal rate may be so low as to be unreachable (as policy would lose traction because of a shift to cash before hitting it).
There is the possibility that central banks reduce uncertainty about future policy rates through forward guidance and, as a consequence, reduce the term premium (Bundick, Herriford, and Smith 2017). Conversely, if the reductions in term premiums achieved via quantitative easing-induced portfolio rebalance affect the economic outlook, they can also affect the expect path of future policy rates (Bernanke 2020).
Rostagno and others (2019) find that a similar mechanism can contribute to explaining the increased effectiveness of forward guidance in the euro area.
However, these results may not necessarily apply for countries where, for instance, the monetary regime differs from inflation targeting.
In surveys of household inflation expectations, sizable proportions of respondents choose “Don’t know” as a response to questions about near-term inflation rates (for example, Coibion, Gorodnichenko, and Weber 2019).
In both prospect theory and aspiration-level theory, zero is a special number—a reference point—for portfolio allocation. Both theories predict large changes in the composition of portfolios—risky vs. safe assets—for small changes of the risk-free rate around the reference point. However, prospect theory would require a high level of loss aversion (that is, a much steeper value function for losses than for gains) to generate significant changes in portfolio allocations once risk-free rates turn slightly negative. Alternatively, aspiration-level theory can produce large shifts in allocations by introducing a discontinuity in the value function around the reference point. Although similar, these two theories have slightly different implications: while prospect theory predicts the effect of interest rate cuts on portfolio choice to be the same when going from positive to negative and from negative to further negative, aspiration-level theory predicts the first cut into negative territory to have the largest effect. In contrast, under expected utility theory, a decline in the risk-free interest rate could discourage risk-taking via wealth effects.
In many jurisdictions, some form of deposit insurance scheme provides safety to retail depositors.
An alternative action on the part of banks would be to allow deposit funding to flow out. When deposits are transferred from one bank to another, reserve balances shift along with them, leaving the aggregate amount unchanged. Allowing deposits to leave would therefore allow the bank, but not the banking sector as a whole, to save on the costs associated with reserves that pay negative rates. In countries where reserves are abundant, such as the United States, such a policy may be feasible (for an individual bank, although not for banks as a whole) but probably not desirable. Liquidity regulations such as the Basel III Liquidity Coverage Ratio require banks to hold high-quality liquid assets in proportion to certain types of market funding, and reserves are preferred by large banks as they provide the most readily available form of liquidity.
The link between bank net worth and policy rates drives this bank-capital channel of monetary policy (Van den Heuvel 2001, Disyatat 2011). When rates are not too low and as long as banks have positive duration gaps (that is, the duration of their assets is longer than that of their liabilities), rate cuts should increase banks’ market value of equity and, consequently, their ability to lend. This may be reversed, however, when rates are below the reversal rates, as previously discussed.
The effect of NIRP on this deposits channel of monetary policy hinges on banks maintaining market power over depositors and facing an inelastic supply of deposits. However, a ZLB on retail deposit rates suggests some weakening of banks’ market power and of the deposits channel under NIRP (Brown 2020).
Dell’Ariccia, Laeven, and Marquez’s (2014) risk-shifting argument applies to interest rate hikes because those are perceived as having adverse effects on bank profitability. However, the argument also applies to NIRP (but not necessarily to low-but positive rates) if indeed it reduces bank profits.
Tis limited ability to reach for yield could either be because of regulatory and supervisory action or because of market discipline, whereby end investors redeem their MMF shares if they believe they have become too risky. However, this is not really a problem solely of NIRP but more generally of low interest rates (Di Maggio and Kacperczyk 2017).
CNAV funds are now disallowed in many jurisdictions, including the European Union. In the United States, CNAVs are not allowed for prime MMFs, but are still allowed for retail and Treasury-only MMFs (McAndrews 2015).
These funds are relatively more important in the United States and significant outflows could trigger funding disruptions for the financial and nonfinancial sectors (Burke and others 2010).
In addition, the circumstances that cause the need for monetary easing may themselves be short-lived (for example, see Lane (2020) on the use of NIRP to counteract the COVID shock), even if this is not exclusive to NIRP.
These are the only countries so far wherein a key monetary policy rate has turned negative. Other central bank rates, but not key policy rates, have been at times negative in other countries (for example, Hungary) but these do not constitute examples of NIRP (see Jobst and Lin 2016).
The fall in 500 euro notes may be driven by the decision to discontinue issuance by the end of 2018.
A recent rise in banknote usage was related to the end of the banknote and coin changeover initiative that took place between 2015 and in 2017 and had depressed cash usage (Armelius, Claussen, and Reslow 2020).
YCC aims to shape the yield curve by targeting both short-term and long-term interest rates.
A similar argument explains the reduced sensitivity of medium- and long-term yields to macroeconomic news after 2011 (Swanson and Williams 2014a).
Faced with the challenge of avoiding appreciation, the Danmarks Nationalbank (DN) and the Swiss National Bank (SNB) intervened in the FX market after 2010. Although FXI was successful in ensuring exchange rate stability, the required size of these interventions turned out to be very large, which increased the size the central banks’ balance sheet and their exposure to exchange risk. The DN—which was able to maintain the peg with the euro—and the SNB eventually decided to adopt NIRP and reduce the size of its FXI.
There is evidence that with low interest rates, the exchange rates of major currencies became more sensitive to changes in monetary policy expectations already before rates became negative (see Ferrari, Kearns, and Schrimpf 2017) and at least since the 2007–09 crisis (Curcuru 2017). Also, Swanson and Williams (2014b) found that the exchange rates of the euro and British pound against the dollar were not constrained by the ZLB.
Ampudia and Van den Heuvel (2018) use intraday, tick-by-tick data on interest rate swaps, sovereign bond yields, and individual bank stock prices to estimate the effects of monetary policy in the euro area. Altavilla, Boucinha, and Peydró (2018) also use bank-level data to estimate the reaction of bank equity prices and CDS spreads to conventional and unconventional monetary policy, but do not look at the effects of NIRP in isolation. Based on aggregate data, Varghese and Zhang (2018) also find significant effects on sovereign CDS spreads, equity and bank equity, government bond yields, exchange rate, and inflation swap rates.
In Denmark, at least initially, firms did not lower their total bank deposit holdings but shifted away from demand deposits into higher-yielding time deposits (Jensen and Spange 2015).
Before NIRP, the literature on the effects of monetary easing on bank profitability found that interest rate cuts depressed bank profits (for example, Hancock 1985).
In relative terms, the income of large banks and those that rely relatively less on deposits performs better under NIRP.
Several studies have used bank heterogeneity to better identify the effects of NIRP on banks’ net interest income and profitability. Some have relied on exploiting exogeneity in banks’ reliance on retail deposits to make inferences on the importance of the ELB for NIRP. Similarly, many researchers have used the amount of cash-like assets as a proxy for how banks are affected by NIRP. Other approaches classify banks based on their size, business model, or responses to dedicated surveys. Finally, some studies simply compare the impact of cuts in official rates to low, but still positive, levels with that of cuts in negative territory.
The literature offers conflicting findings relating bank capital and the effect of rate cuts on bank profits. For example, Molyneux, Reghezza, and Xie (2019) find that well-capitalized banks see bigger declines in profits, but Arce and others (2018) find that the net interest revenue of banks with low capital is more adversely affected.
The only study that ranks banks in terms of retail deposits and excess liquidity simultaneously also finds a positive impact of NIRP on lending (Demiralp, Eisenschmidt, and Vlassopoulos 2019).
Eggertsson and others (2019) describe a theoretical model of the transmission of monetary policy through the banking system. In their model, banks may respond to negative policy rates by raising the spread between their lending and borrowing rates. The wider spread tends to depress output and inflation, rather than stimulating them as intended. However, this result rests on assumptions that (1) there is one type of liability (deposits) subject to the ELB, (2) the marginal benefit to holding reserves in terms of reduced intermediation costs can be driven to zero, (3) the marginal cost of issuing loans rises as bank profits fall, and (4) the central bank attempts to set a policy rate below the ELB. The consequence is that when the central bank sets rates below –0.01 percent, the assumed ELB, it causes bank profits to be lower, and so leads to a contraction in loan supply. See also Ulate (2021) for a similar exercise that reaches very different conclusions.
There is only one study that does not find any effect of NIRP on bank lending growth (Michail 2019).
Klein (2020) finds that the positive relationship between NIM and new lending to the nonfinancial private sector disappears in the presence of NIRP. In line with this finding, Hong and Kandrac (2018) find that banks more adversely exposed to NIRP (based on stock price reactions) increased lending more. But, according to Arce, Rose, and Spiegel (2018), the behavior of banks that identify themselves as negatively affected by NIRP is not different from the response of other banks.
However, Arce and others (2020) find the opposite for euro banks in general and Spanish banks in particular: banks with NIM more adversely affected by NIRP reduce risk-taking in lending to shore up their capital.
These changes were not without precedent. Between August and November 2003, repo rates in the United States were sometimes negative and low rates remained low (but positive) even for uncollateralized lending until 2004. As a consequence, MMF yields fell and AUM by MMFs fell by about 15 percent during 2003–04. However, the decline was very gradual and did not disrupt funding markets (Dwyer and others 2008).
The EU adopted a far-reaching reform of its money market regulation (Regulation (EU) 2017/1131, fully implemented in March 2019), further confounding the analysis of the effects of NIRP on the MMF industry.
There are two reasons for this. First, banks have increasingly passed on negative rates to insurers and pension funds’ deposits, and to a much larger extent than to nonfinancial corporations or households. Second, among domestic investors, Danish life insurers and pension funds are only second to banks as holders of Danish mortgage bonds, and these bonds compose 33 and 44 percent of their assets, respectively. Returns on investment for life insurers and pension funds, since January 2018 has been between –1.10 and 1.86 percent. For Danish krone-denominated mortgage bonds, return on investment has been between –0.09 and 0.66 (data from Danmarks Nationalbank Statbank).
Bloomberg Law. 2019. “A $440 Billion Pension Market Sounds Alarm as Liabilities Swell.” October 7. https://news.bloomberglaw.com/employee-benefits/a-440-billion-pension-market-sounds-alarm-as-liabilities-swell.
These estimates are similar to those of D’Amico and others (2012) and Christensen and Rudebusch (2012) for the United States and the United Kingdom. The size of ECB purchases relative to GDP (3.5 percent) was much smaller than that of the Federal Reserve, Bank of Japan, and Bank of England (22.1, 37.3, and 26.3 percent, respectively; Fawley and Neely 2013).
Ulate (2021) uses a DSGE model to conclude that the relative efficiency of a 100 basis point cut into negative rate territory in welfare terms is between 60 and 90 percent of that of the same sized cut in conventional positive territory.
See Dell’Ariccia, Rabanal, and Sandri (2018) for a summary of these effects.
The adverse effect of NIRP on bank profitability is exacerbated by the amount of excess reserves in the system (for example, because of FXI or APPs). See Chapter 2.
To ensure that very short-term money market rates are close to the floor of the interest rate corridor, the amount of excess liquidity remunerated at the deposit facility rate needs to be sufficiently large. Intuitively, if all excess reserves were exempted from negative rates, the cost of holding liquidity would stop being negative.
Although monetary policy may have distributional effects, the literature suggests that monetary policy easing has a net beneficial albeit small effect on inequality, mostly because it lowers unemployment (Coibion and others 2017). However, the evidence on unconventional monetary policy measures is inconclusive (Amaral 2017). Furthermore, there is a substantial gap between the public perceptions of the distributional effects of monetary policy and the best quantitative estimates of them (Haldane 2018).
This is essentially the opposite case from QE, as captured by former Federal Reserve Chairman Bernanke’s famous statement that “the problem with quantitative easing is that it works in practice, but it doesn’t work in theory.” See Brookings Institution (2014).
The need for clear communication on whether negative rates are in the toolbox, even when not used, has the added benefit of allowing financial system to prepare. This may also be important for the distribution of expected future interest rates.
Coordinated action among monetary, prudential, and fiscal policies may also reduce the need for NIRP. That is, monetary policy measures are not the only game in town. For jurisdictions wherein fiscal buffers are available, a shock to aggregate demand can be met with deficit spending. For example, the Norges Bank statements highlight Norway’s room for fiscal maneuver (Olsen 2019). Similarly, the release of macroprudential buffers can provide a measure of support to the financial system in the event of a crisis, and thereby buttress conventional monetary policies (Bank of England 2020).
Alternatively, it could reflect a greater aversion to cross-sectional variation in consumption relative to inter-temporal inequality (Jung 2019).
Implementing even more negative rates may require more extreme measures such as taxes on cash or the elimination of large denomination bills (for example, Agarwal and Kimball 2019, Lilley and Rogoff 2019).
Danmarks Nationalbank’s interest rate on reserves—the current account deposits rate—has been close to zero since July 2012. However, Danish banks can hold only a limited amount of reserves, with excess liquidity being converted to negative-interest-bearing certificates of deposit (Angrick and Nemoto 2017). When the text refers to negative central bank rates in Denmark, it means a negative rate on DN certifcates of deposit.
Although the Riksbank, Sweden’s central bank, lowered its overnight deposit rate to –0.25 in July 2009, this is not the Riksbank’s official policy rate.
Reuters. 2019. “UPDATE 1-Denmark’s Jyske Bank Lowers Its Negative Rates on Deposits.” September 20. https://www.reuters.com/article/denmark-rates-jyske-bank/update-1-denmarks-jyske-bank-lowers-its-negative-rates-on-deposits-idUSL5N26B1AA.
Schartzkopf, Frances. 2019. “Negative Rates are a Cash Cow for Denmark’s Mortgage Lenders.” Bloomberg, September 4. https://www.bloomberg.com/news/articles/2019–09-04/negative-rates-are-a-cash-cow-for-denmark-s-mortgage-lenders.
Ibid.
The ICR is the ratio of earnings before interest and taxes to net interest expenses, provided the latter are positive.
The empirical evidence suggests that monetary policy accommodation, including that from negative interest rates, improves the trade balance (for example, Ca’ Zorzi and others 2020).
The Riksbank’s market operations meant that, in practice, overnight rates remained positive and the deposit rate being negative was of no consequence (Burke and others 2010).
Macroprudential policy is usually better suited to dealing with issues of financial stability (IMF 2015). But at that time, Sweden lacked an institutional framework for macroprudential policymaking.
Riksbank. 2009. Monetary Policy Report. July. The report states (p. 21, emphasis added): “Although one can in principle consider even a negative repo rate to be possible, it is the Riksbank’s assessment that the repo rate, after the cut made now, will have in practice reached its lower limit, and that it is not appropriate to cut the rate further than to 0.25 percent.”
As noted before, in Eggertsson and others’ (2019) model of the transmission of monetary policy, banks may respond to negative policy rates by raising the spread between their lending and borrowing rates, which depresses output and inflation. However, this is a consequence of the central bank setting a policy rate below the ELB (calibrated at –0.01 percent), among other assumptions.
In small open economies that do not have safe haven status (unlike Switzerland), low interest rates in large AEs do not effectively constrain their monetary policy because they have a positive currency risk premium.
Several Swiss banks are now charging interest on large deposits (for example, Revill and Hirt 2019).